You have to consider multiple factors while investing, not just returns

There are multiple factors that go into selecting the right investment products to meet our financial goals. Here is why.

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Jul 14, 2018, 09.00 AM IST

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Various parts of the investments perform at different points. They are all required to make a good portfolio.

By Suresh Sadagopan

You are in the showroom to buy that car you have always wanted to get. You discuss with the salesperson regarding the distinguishing features of the car. You may even want to take it for a spin to get a feel of the car in terms of driving comfort, cooling inside the car, road handling, fuel efficiency etc. We rarely obsess over a single factor like the maximum speed or the fuel efficiency and base our decision to buy the car just on that.

However, when it comes to investments, most people seem to be obsessed with just returns while excluding other factors. This is like buying a car that travels fastest. If you go by this logic, then all ofus would only be driving Lamborginis and Ferraris. A big flipside to doing this is that you will not be able to drive it that fast on our pothole riddled roads.

How obsession with returns is actually detrimentalIf we are just obsessed with returns while investing, we are going to worse off for our efforts. There are multiple factors that go into selecting the right investment products to meet our financial goals. Here is why.

An example can clarify this. Tej is putting money in equity. He is doing this because it is doing well at the moment. He sees that the markets are going up, he takes money out from everywhere and invests them in equity. After a month, the equity market starts collapsing. Someone tells him that if you pump in money when the market falls, you can make more money when it goes up. Tej pumps in more money. The markets falls further. After three months, the market is down about 10 percent. Tej wants to get out but is not sure.

He asks his friend Ramu. Ramu says that equity is a chump's game and chides Tej for getting into equity. He extols the virtues of cryptocurrencies, which have been going through the roof. He has invested in it and is seeing excellent returns. Tej is hooked. He is unhappy as his equity portfolio is not doing well. But still he hesitates. After ten days when he meets Ramu, he says that cryptocurrencies have gone up by another 5 percent in this period. Tej is shocked. He cashes out all his equity investments and puts it into cryptocurrencies. He is happy for a while. But after that it starts its monumental slide. After two months, the value is just one-fifth of what he started with.

Tej is dejected and is waiting for a bounce back. In the meantime, he is looking for other avenues which can give returns, where he can switch this investment. Equities have again started rallying and is now ruing the decision of shifting from it. He is in fact considering switching back to equities.

This is what happens regularly with investors due to greed, fear, anxiety about future earnings, and herd mentality. I would say that about four-fifths of all people have some shades of Tej in them.

Well-thought out portfolio and staying invested makes senseMost people invest randomly, they just put money in every new investment that comes their way. Some people have told me that they invest in equity as they find it exciting. The upshot - no one has a well though-out plan of investment to achieve their future goals. Their only plan is to try to get the maximum returns at every point.

What is needed is a proper analysis of one's situation, goals, expenses, liquidity needs etc., and a portfolio that would help in achieving it, over time. The portfolio would consist of a well thought out mix of assets. The assets will mostly stay in place irrespective of returns. For instance, if gold was a part of one's portfolio, it is a strategic allocation, a hedge in the portfolio as it is uncorrelated or negatively correlated with equity, currency, and other assets. Every asset has a risk and reward and the portfolio should be carefully constructed taking this into account. The portfolio return is what one should be overall concerned with- not each individual component. Even in case of portfolio returns, it may be poor at certain points. As long as we know that it will recover and make up over time, we should not be concerned.

Portfolios need to be reviewed from time to time and changes need to be made due to one's changing circumstances. What is most important is regularity in investment, discipline, patience, and a cool head.

We have heard that Rome was not built in a day. A good portfolio likewise takes time to settle and generate returns.

Give it leeway, like you give your childrenWe give a lot of leeway to our children. We give them an extra wide berth even if they have acted in downright stupid ways. Blunders are tolerated. Overtime, the mistakes get rectified and they are back on track. In time, their transgressions are even forgotten.

Why not treat your portfolio with the same understanding. The assets we invest in have a history of how they have performed in the past. That would at least give you an inkling of what you may expect in future. Time changes everything. A so called dud of today will fire three years later. To enjoy that in future, you need to be invested from now - for no one knows the right time to get into an asset. The Tejs and Ramus of the world would pretend that they know the right time to enter and exit. Sadly it's just ignorance and sometimes hubris.

What you should doWe need patience -- we need to give our investments time. Various parts of the investments perform at different points. They are all required to make a good portfolio. We cannot always look only at the fuel efficiency or the speed to buy a car. We cannot obsess over investment returns to the exclusion of everything else.

(The author is Founder, Ladder7 Financial Advisories.)

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)